Capitol Hill Blue Forums Political Issues Finance, the economy & Economics How will the financial crisis develop?

In the course of one tumultuous weekend, US treasury secretary Hank Paulson and Federal Reserve chairman Ben Bernanke have permitted one bank to go under and another bank to be quite unexpectedly sold.
For some observers, the news is almost enough to bring on a 'Jim Cramer moment' – a meltdown broadcast on TV in August last year when the CNBC pundit Cramer wondered whether the US government had any concept of the trouble brewing in the US housing market.
Orchestrating a sale and a bankruptcy in such a short period of time has certainly led to an acute sense of crisis both in the US and internationally. For a start, no one believed the sale of Merrill Lynch was so imminent; there had been very little discussion of a sale prior to this weekend.
But the act of allowing Lehman Brothers to go bankrupt is especially high risk. The fire sale price of the mortgage-related assets that Lehman will now have to unload will depress prices across the board – including similar asset classes held by all the other major financial institutions.
The fact that Washington Mutual and AIG – a deposit-taking bank and a major insurer even more important to the financial system than two broker-dealers – and also struggling suggests that the timing of Lehman’s demise could not have been worse. It may even provoke the dreaded 'domino effect', when investors panic and dump all financial shares, or in WaMu's case pull out their deposits, because there is no clear commitment from the government in the event of a crisis.
The risk now is that sagging stockmarkets (inevitable after the failure to bailout Lehman) and a weakening dollar (equally inevitable) will affect the capital adequacy ratios of even the healthy commercial banks in the US. This will force them to reduce lending, worsening the credit squeeze, and condemning the US economy to further pain.

Paulson's current opposition to a Wall Street 'bailout culture' developing rings hollow compared to his and Congress's inability to properly regulate the banks in the first place.

Ultimately, this is a heavy blow to the US model of capitalism. Very few countries around the world will now be tempted to open up their capital markets to turbo-charge growth. The US’s own transition from manufacturing to financial services has suffered a huge setback, even as China takes over its mantle as the world's biggest manufacturer. The UK is next in line, with its even more 'manufacturing light' model – mortgage-lender HBOS is already being shredded. But while Asian countries may be feeling smug, they are in trouble as well, with suddenly much fewer outlets for their manufactured goods. The world suddenly looks a much more dangerous place.